Liberty Mutual to buy Safeco for $6.2 billion

SAN FRANCISCO (MarketWatch) — Liberty Mutual Group said on Wednesday that it agreed to buy auto insurer Safeco Corp. for more than $6 billion in cash in a deal that would create the fifth-largest property and casualty insurance company in the U.S.

The acquisition also suggests the sector may be ripe for consolidation after several years of lackluster deal-making.

Hanover Insurance Group
Mercury General
Navigators Group
and SeaBright Insurance

were highlighted as possible takeover targets by some analysts. Those stocks rallied during morning trading Wednesday.

Liberty, a big, Boston-based mutually owned insurer that sells personal and commercial policies through independent agents, said it agreed to pay $68.25 a share for Safeco
a Seattle-based company that specializes in auto insurance and surety policies.

The deal values Safeco at roughly $6.2 billion, or 1.8 times book value. The offer is a 51% premium to the target company’s Tuesday closing price of $45.23.

Shares of Safeco
surged 46% to close at $65.94 on Wednesday.

The property and casualty insurance business has experienced several years of big profits. But the industry is cyclical. When insurers generate strong earnings they sometimes try to put that extra cash to work underwriting more risks. As companies compete to win new business, prices fall, which can undermine future profits and lead to losses.

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The auto insurance business, a focus of Safeco, has experienced particularly tough competition and rates have dropped. Safeco shares had declined 32% in the past year, before Wednesday. Shares of Progressive
and Allstate
two of the largest auto insurers in the U.S., are down 23% and 22%, respectively, in the same period.

However, the industry has so far avoided the worst of the mortgage-fueled credit crunch. While growth may be limited by competition and falling prices, profits remain relatively healthy for now and balance sheets are holding up, analysts say. That could spark more consolidation as some insurers look to boost growth through acquisitions, they added.

“Many areas of the property and casualty sector remain undervalued and attractive, as fundamentals and balance sheets across many companies remain solid,” Alain Karaoglan, an analyst at Banc of America Securities, wrote in a note to investors.

Cliff Gallant, an analyst at Keefe, Bruyette & Woods, said regional property and casualty insurers and specialty insurers, such as Hanover, Navigators, Eastern Insurance
SeaBright and Mercury, are attractive targets.

Liberty Mutual said Safeco was attractive because its products and operations complement the Boston company’s agency business.

The insurer was also lured by Safeco’s surety business. After the deal is completed in the third quarter, the combined company will be the second-largest surety business in the U.S., Liberty said.

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“The addition of Safeco significantly expands and strengthens the Liberty Mutual Group,” Edmund Kelly, Liberty Mutual Group chairman, president and chief executive officer, said in a Wednesday news release.

Safeco will become part of Liberty’s Agency Markets business after the deal. That unit had $5.7 billion of revenue in 2007. Together, the new unit will work with 15,000 independent insurance agencies, Liberty noted.

Paying for the deal

Liberty is pay for the acquisition with available cash and some debt. The company will sell up to $1.5 billion of hybrid and senior debt to finance some of the deal, influential insurance industry rating agency A.M. Best said.

A.M. Best said it’s not changing its ratings on Liberty, but the agency warned that after the acquisition, the insurer will have “limited financial flexibility for future events relative to its ratings based on current financial leverage measures.”

Standard & Poor’s said it may downgrade the ratings of Safeco and Liberty Mutual after the deal.

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